Speeches and Papers

Presentation at a conference sponsored by the Johns Hopkins School of Advanced International Studies and the Center for Global Development, "New Ideas in Development Finance after the Financial Crisis"
April 22, 2009

The financial crisis that currently engulfs the world is largely a consequence of deficient regulation. The world economy enjoyed a cyclical upswing for much of the 2000s, and it is true that such upswings inevitably end, but they do not all end up in financial crises. It seems to me that it was failures of the regulatory system, not the absence of regulation for certain institutions—the regulated and unregulated appear to have been equally prone to fail—that should be blamed for the severity of the current crisis. What I hold responsible is the fact that the system of regulation that we had did not penalize the right things—bigness, increasing leverage in a boom, maturity mismatches—and therefore invited failure. Accordingly I welcome a revision of the system of regulation as was announced at the G-20 summit.

Since the background paper specifically mentions the Washington Consensus, I must say a word or two on this topic. I offer three comments. First, as originally conceived the Washington Consensus advised not simply the microeconomic liberalization mentioned in the background document, but also macroeconomic discipline and opening up (globalization). The background paper provides a misleadingly partial view by mentioning only one of the three main elements. Second, according to the alternative version espoused by Joe Stiglitz and apparently endorsed also by the background paper, the Washington Consensus was a neoliberal manifesto. But neoliberalism is normally considered to embrace such doctrines as monetarism, reduction of the progressive thrust of taxation, opposition to state action to redistribute income, and minimization of the role of the state, rather than just the reasonable liberalizing (micro) reforms mentioned in the background document. These additional doctrines never did command a consensus in Washington so I do not consider them part of a Washington Consensus. Third, the particular point that I tried to make by inventing the term was that events had led to a unification of the doctrines espoused for developed and developing countries. No longer was it to be assumed that developing countries were different because peasants were not profit-maximizers, modest inflation was to be tolerated as structural, and import-substitution was a rational way of overcoming balance of payments constraints. The same logic applied to developing countries as had long been applied to OECD countries. This end of intellectual apartheid seemed to me to be progress.

I do not believe that the crisis through which we are living changes the interest of the developing countries save in one important respect. The microeconomic advice that we have given and the report of the Spence Commission are as valid as ever. It remains sensible to use rather than fight the market, but to be prepared to alter a laissez-faire outcome when one of the classic conditions for market failure arises. These are: when monopoly is unavoidable, when externalities are important, and when the resulting income distribution offends social norms.

Ah, the skeptics will say, but Western countries are busy nationalizing and the Washington Consensus called for privatization. True enough. If they were nationalizing permanently for the reason that many countries did in the early postwar years, and that Venezuela has done recently, because they believed that it is socially desirable for the government to command the heights of the economy, one would be right to proclaim the Washington Consensus dead. But if they are nationalizing temporarily because this is expected to have a less-adverse effect on income distribution than alternative ways of saving institutions that are judged too important to be allowed to fail, I do not see a contradiction. I leave the reader to judge which of those is true.1

The one implication for a change in strategy that I do see arising from the current financial crisis and the food and fuel crises of 2008 is macroeconomic. These crises point to the fact that we live in a volatile and uncertain world; we already knew this in general, but probably few of us felt the scope for volatility was so large. Countries are likely to draw the conclusion that it behooves them to have adequate protection against the risks. Those unable to borrow in the market under adverse circumstances, which means virtually all emerging markets and developing countries, need either to self-insure by building up their reserves or command sufficient capability of borrowing on acceptable terms from the International Monetary Fund (IMF). The world will not have a strong recovery if emerging markets and developing countries seek to self-insure, since that means relying on a new round of growth that privileges exports, and the past importer of last resort, the United States, now needs to adjust. But after the East Asian crisis, these countries will only be prepared to rely on borrowing from the Fund if they once again feel it is "their" Fund and if the Fund has the low-conditionality facilities to respond to demands without imposing conditions that are only appropriate when countries have created their own mess. Ergo, it is macroeconomically essential that the Fund reforms its governance to give a fair weight to emerging Asia and to allow all countries to borrow on low-conditionality terms when hit by a shock beyond their national control. Its Flexible Credit Line provides the necessary funds for market borrowers. Now it needs to complete its arrangements by reinstating the Compensatory Financing Facility.

We are also invited to speculate on whether the crisis has any implications for the prospects of developing countries adopting democratic forms of governance. Since the Western democratic countries have not covered themselves with glory, the crisis is unlikely to be helpful. But I doubt whether a dominant motive for adopting democracy is opinions about the international ramifications of other countries' policies: I suspect that most countries become democratic because their own people want a say in how they are governed. If that is right, the implication would seem to be that the crisis is unlikely to have a great impact in this area.

Note

1. Skeptics may also be inclined to point to the recommendation to deregulate. But in the days when Dan Quayle was Vice President I already made it clear that this was intended to endorse freeing entry and exit, rather than to advocate an absence of regulations intended to protect the consumer, or the environment, or to supervise the banking system. With that interpretation there is no contradiction.